By Yali N’Diaye

WASHINGTON (MNI) – Standard & Poor’s Tuesday lowered its 2013
economic outlook for U.S. states and local governments, while it is now
projecting steeper federal spending cuts next year than it had
anticipated in July.

Some entities have already implemented cutbacks in services, but “a
smaller number of them,” Standard & Poor’s warned, “have begun to
approach a service level floor.”

Yet the rating agency said in a report it still expects “most state
and local governments will navigate this with their credit quality
intact.”

Standard & Poor’s also “identified several economic risks that
could heighten the chances of negative credit pressure,” notably a
potential contagion from a eurozone crisis, a harder-than-expected
landing of the Chinese economy, and the so-called fiscal cliff in the
United States.

“Credit implications to individual state and local governments from
these macroeconomic risks vary,” said the report titled “U.S. State And
Local Government Credit Conditions Forecast: The Difference This Time.”

“Those governments with limited revenue-raising ability, greater
economic reliance on exports, and greater economic or fiscal reliance on
federal spending would be most affected,” wrote the authors led by
analyst Gabriel Petek.

Asked about the impact of the weaker outlook on states and local
governments’ credit, Petek told MNI “We have not delineated how states
may be affected versus locals.”

“However, we know that many states rely heavily on personal income
tax collections including capital gains income,” he said. “To the extent
the stock market has performed relatively well, and in anticipation of
the possibility for higher federal income tax rates beginning in
January, we think states could see a bit of an uptick in those
revenues.”

“This would likely be beneficial to their budgets and, therefore,
credit quality,” he added.

Instead, local government rely more on sales and property taxes for
their revenues.

“Because of the time involved in the assessment process, even if
the housing market has hit bottom and is starting to show some modest
home price increases, it could be a while before property
assessments-which are the basis for property taxes-see an increase,”
Petek told MNI. “That said, any life in the real estate sector,
including new development of single-or-multifamily residences would be
beneficial to revenue trends since there is not the same delay as long
as a property sales.”

Standard & Poor’s said in its report that the baseline forecast for
states and local governments is “slightly negative” for 2013, a
deterioration from “stable” in 2012. Under the best scenario, the sector
economic outlook is stable next year.

On a regional basis, Standard & Poor’s sees the strongest growth in
the West South Central region and the weakest in the East North Central
region next year.

The rating agency projects a 2.5% decline in federal spending for
2012, and a 3.2% decline for 2013, more than the 3% cuts forecast in
July.

Economic risks have been highlighted by the major rating agencies
as a source of uncertainty for the states and local government budgets.

In fact, on September 19, Moody’s said it maintained a negative
outlook for U.S. states for the next 12 to 18 months, “reflecting the
ongoing macroeconomic risks and persistent budgetary challenges states
face.”

However, “default risk implied by state ratings even at the weakest
level (currently A2) remains low,” said Moody’s, which also maintains a
negative outlook for local governments.

It is likely to maintain the outlook negative until “there are more
significant and longer-lasting gains in the economy that foster
improvements in local government budgets.”

At Fitch Ratings, analysts said on September 20 that the U.S.
states outlook remains stable despite uncertainties that include the
economic and fiscal outlook.

During a conference call with reporters, they also said that while
they do expect more bankruptcies in California, they will be isolated
and will not happen among cities.

** MNI Washington Bureau: 202-371-2121 **

[TOPICS: MR$$$$,M$U$$$,M$$FI$,MFU$$$]